Do 1980s' timing strategies still work?: "definitely not." (short-selling and market-neutral funds) (Pension Fund Management)

• Author: Belquist, James R.

"DEFINITELY NOT"

In 1990, we hired two firms to manage market-neutral portfolios for the US WEST pension trust. We were convinced we could greatly enhance the returns of a cash-only account by using dynamic new approaches to portfolio management. Our experience during the next two years was disappointing, however, and we ended the program in 1992.

When we began to investigate short-selling as a pension-fund strategy, it was a relatively novel concept. The strategy was designed to capture only alpha, or the volatility stemming from the security itself, rather than the overall market. Few pension funds were using the strategy, but the opportunity to enhance returns and facilitate asset-allocation decisions appealed to us. Asset-allocation decisions could be more efficient, since we could move and aggregate a market-neutral strategy into different asset classes merely by overlaying with either bond or stock futures. Finally, we liked the idea of investing short, because that seemed to be an inefficient area of the U.S. stock market.

We used the plain-vanilla concept of market-neutral portfolios. To us, that meant buying the stocks ranked at the top end of the manager's universe list and selling the stocks at the bottom of the list. Diversifying across all industries largely eliminated the market risk. This strategy was quite different from the one employed by Alcoa, which primarily used arbitrage strategies. Once we'd decided on the plain-vanilla market-neutral strategy, we gave Firm A $50 million and put an S&P 500 futures overlay on the portfolio. We invested $50 million with Firm B and put a bond futures overlay on the portfolio. We intended to track the performance of these two firms, understand the investment process in greater detail and eventually increase that funding within six to 12 months. During the succeeding two years, many more firms began to market the strategy. In fact, we started to track the calls from companies preparing to sell the market-neutral strategies. We quit counting after 30 calls in the first three months of 1993. While these calls did not deter us, they show the industry's increasing interest in this strategy.

But by early 1992, return expectations of the plain-vanilla approach had decreased significantly. Returns in 1990 were expected to range from 5 percent to 10 percent, but for many companies, these expectations had dropped to 1 percent to 2 percent less than two years later. By the middle of 1992, the...